Macroprudential measures may be employed to prevent a housing bubble burst.

There has been a continued focus on the hot domestic property market as an economic risk due to soaring property prices – especially in Sydney and Melbourne. The Reserve Bank fuelled this debate recently with its semi-annual Financial Stability Review taking aim at unbalanced housing markets. The Bank is concerned that house price growth is getting well out of kilter with income growth, creating the risk of a sharp property price correction which then has broader economic consequences. It sees investor lending as the key culprit of late. More recently, the Australian Prudential Regulation Authority has outlined further steps it plans to take to reinforce sound residential mortgage lending practices, including addressing the growth in lending to property investors, focussing on higher risk mortgage lending and guidance on loan affordability tests for new borrowers.

It is true that the past 18 months has seen a stellar run for Australian house prices, particularly for Sydney and Melbourne. Those markets are still performing strongly, supported through this year by a pick-up in international student numbers into Australia, increased demand from investors and increased migration flows. Of late, more solid house price gains are also being registered for Brisbane and Adelaide, though post mining boom Perth has been weaker.

The ABS House Price Index for Australia shows that nominal house price growth was running at 10% over the year to June 2014. This compares to 5% over the year to June 2013, - 1% to June 2012 and -2% to June 2011. Growth in Sydney over the year to June 2014 was nearly 16%. Monthly data since June 2014 suggests that recent house price strength has continued. Other indicators are also strong - auction clearance rates are above average, while the time taken to sell properties and average discounts being offered are currently low.

Low interest rates provide the potential for such rapid house price gains to continue. Measures of mortgage stress (the ability of households to service their housing debt) remain well below their average over the last decade. This suggests that households can afford to borrow more, although there is vulnerability if interest rates increase. Furthermore, access to credit remains high due to low funding costs for banks and increased competition.

Additionally, returns on other assets – such as equities and term deposits – remain low. We expect this to continue in a world of ‘easy money’ with global interest rates expected to remain low for the foreseeable future. This will continue to increase investor demand for property – even as price to rent ratios continue to fall.

But there are some constraints which will also start to kick in. The weakness in underlying income growth stemming from the soft labour market remains a drag on further housing price gains. The very strong rises in house prices already recorded, particularly in Sydney and Melbourne, are also beginning to stretch valuations in terms of rental yields for investors as well as affordability for first home buyers. In addition there is a big lift in housing supply coming through the pipeline, which will give property buyers more choice and dampen upward pressure on prices.

But until house price growth does settle down, the Reserve Bank is left in a difficult waiting game. It needs to keep interest rates low to support a broader economy which is growing at below trend rates. But in doing so it can see that imbalances are building in the housing market, and it is running out of patience for those to self-correct.

There is some good news – rising house prices are changing the ‘build versus buy’ equation. The higher that house prices go, the less sense it makes to buy an established dwelling, and the more sense it makes to build a new one (or buy from developers).

Combined with other favourable conditions – low interest rates, population growth, inducements for first home buyers and overseas investment (particularly from China) – there are many factors driving higher levels of housing construction at present.

This is reflected in a range of housing activity data. Housing finance statistics show that housing-related lending is up 20% for the year to October 2014. Similar gains are being seen for residential building approvals, up 15% over the same period. The quantum of residential building activity is also up 9% for the year to June 2014. This compares to 4% for the year to June 2013, 6% for the year to June 2012 and -2% for the year to June 2011.

This improvement in housing construction activity may extend into 2015 and beyond with State Governments working to reduce supply side constraints. However, approval for housing supply expansion also needs to go through local Council approvals processes, which can take time, and many local Councils continue to stand in the way of increased property construction.

An increase in building sector activity will help to smooth the transition resulting from the end of the mining investment boom by absorbing mining construction sector workers. It will make the RBA’s delicate balancing act on interest rates easier if there are broader reasons to suggest there should be an interest rate hike – not just rapid house price growth in two markets led by investors.

In the meantime there are alternative measures which could be employed to slow house price growth, other than the broad sledgehammer of interest rates, with discussion of macroprudential measures on the table at present.

The rise in house prices has led to speculation that macroprudential measures may be employed to prevent the perceived ‘bubble’ bursting and sending shocks through the broader economy.

The Financial System Inquiry (FSI) Interim Report notes that a number of jurisdictions internationally, including New Zealand, have implemented macroprudential policies which are intended to improve their economies’ resilience to shocks emanating from the financial system.

While the RBA has commented on the current strength of investor activity in the housing market, especially in Sydney and Melbourne, it has not advocated new macroprudential policies to quell house prices.

To date, Australia’s financial system and its current approach to dealing with systemic risk – which consists of informal discussions between the APRA and the RBA, public communication and limited macroprudential powers – has proven to work well, including during the GFC.

Some countries have introduced additional macroprudential measures intended to help in the case of a ‘bubble’. Australian regulators have expressed their satisfaction with the current arrangements.

As seen during the GFC, systemic risk can be very difficult to predict, define and contain narrowly. To address risks in a formulaic manner is problematic and may in fact be counterproductive.

Australia already has two bodies dealing with macrostabilisation: the RBA (through interest rates) and the government (through policies addressing unemployment).

International evidence around the ineffectiveness of macroprudential measures

If house price growth does moderate over the next few months, either by such action, the RBA’s jawboning, or just naturally running out of steam, there will be far less pressure for interest rates to start rising in early 2015. Otherwise – early 2015 rate rises are very much on the cards.

Director, Deloitte Access Economics

Mike is an experienced economist with broad-based expertise gained over more than two decades of practice. Mike joined Access Economics (now Deloitte Access Economics) in 2007, after 15 years working ... More

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